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June 21, 2012

Eurozone Slumps Further as Fidelity Predicts Bailouts for Spain, Italy

Economic woes continue; Britain plans action on executive pay

Despite the formation of a new government in Greece—determined to renegotiate the terms of its bailout—and a rescue for the banking sector in Spain, it looks as if a long hot summer is in store for the eurozone as financial conditions continue to worsen.

Thursday saw continued contraction in the private sector; Spain and Italy were the subjects of a dire prediction; and in the U.K. the government planned to give shareholders greater say over executive compensation.

Reuters reported Thursday that Greece said it would ask for an additional two years to meet fiscal targets specified in its bailout, and its new government said an extension of unemployment benefits was another key element in its policy. In response to a surge in public pressure and the promise of additional pressure from second-place party Syriza, the pro-bailout parties that make up the new coalition government agreed to a number of changes softening the terms of the bailout and would seek approval for them from eurozone partners.

If there were hints of a breather for Greece, however, eurozone news remained grim. The June Flash Composite Markit Purchasing Managers’ Index indicated a fifth straight month of contraction, with the private sector pulling in its belt at the fastest pace since June 2009.

While a combination index of the services and manufacturing sectors did better than expected by economists polled by Reuters, it still fell to 46, remaining below the 50 mark that is the divider between growth and contraction. It has been below 50 in all but one of the last 10 months.

Howard Archer at IHS Global Insight said in the report of the numbers, "The only remotely positive spin that can be put on the dismal eurozone [PMI] is that there was no further deepening in the overall rate of contraction. Hardly a cause for celebration." Even China suffered, with its factory sector contracting for the eighth straight month in June.

The gloom spread in a prediction by Jamie Stuttard, head of international bond portfolio management at Fidelity in London, who forecast in a Bloomberg report the need for sovereign bailouts for both Spain and Italy within the next 12 months. The result, he said, would shake the global economy.

Between them the two countries carry have 2.8 trillion euros ($3.6 trillion) in sovereign debt, which is four times the debt carried by Greece, Ireland and Portugal and enough to threaten the crisis mechanisms of Europe. In the report, Stuttard said, “We are onto the big countries now. A rescue for Italy is pretty much impossible without a major change in German borrowing costs, a major change in overall eurozone levels of inflation, a major change in the level of the euro, or a major change in the structure of the eurozone.”

Together the two countries would have to come up with about a trillion euros in principal and interest payments through 2014. That’s double the amount European governments have set as the limit for additional rescue lending for the permanent bailout mechanism, set to come online in July— a maximum of 500 billion euros—after already promising 300 billion euros to Greece, Ireland and Portugal. On Thursday, Spain’s borrowing costs continued to rise, topping 6% and reaching a 15-year high.

“This is the biggest crisis with which the IMF has ever had to deal,” Professor Simon Johnson, of the Massachusetts Institute of Technology, said in the report. Johnson, a former IMF chief economist, added, “It’s the entire eurozone that is now in crisis—about a quarter of the world economy.”

Pressure is still building on Chancellor Angela Merkel of Gernamy to commit to direct sovereign debt purchases through the euro area bailout fund. Such a measure has been advocated by eurozone leaders, including President Francois Hollande of France, as a means of stopping the spread of contagion and bringing the crisis to a halt.

However, Merkel said such an action “is not up for debate,” adding, “There is no concrete planning that I know about, but there is the possibility of purchasing sovereign bonds on the secondary market. But this is a purely theoretical statement about the legal situation.”

Reuters reported that the constitutional court said Thursday that it will need time to study the ESM, which, if it wins approval in the German parliament, is set to launch on July 1. A review by the constitutional court could delay its implementation; in the report, a constitutional court spokeswoman said that the ESM is so complex that if it does win parliamentary approval, the court expects President Joachim Gauck to hold off on signing it until the court has had time to study it.

Business Secretary Vince Cable said that the move was intended to improve the link to performance and soothe the public’s anger over executive pay. He was quoted saying, “At a time when the global economy remains fragile, it is neither sustainable nor justifiable to see directors' pay rising at 10% a year, while the performance of listed companies lags behind and many employees are having their pay cut or frozen."

The action follows a number of shareholder votes against compensation packages at annual meetings and previous government action to limit the size of bankers’ bonuses. The European Union is considering similar measures to allow shareholders to have a means of reining in executive compensation.

According to Cable, companies publicly listed in Britain would have to seek shareholder approval for director compensation packages in an annual vote, under laws that could take effect as early as next year. If companies make no change to director compensation, the shareholder vote on pay could be limited to once every three years—a measure on which the Labour Party has accused Cable of backpedaling. Cable’s original proposal had provided for a binding shareholder vote on compensation every year.

Other provisions proposed include binding votes on exit packages and the publishing of a total figure for director compensation so that shareholders can easily determine how much is proposed for pay. Companies would also have to publish a chart that compares chief executive compensation to company performance.

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